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Compound interest should be paid on overpaid tax, says Court

Out-Law News | 01 Apr 2014 | 1:25 pm | 4 min. read

Compound interest should be paid on overpaid tax, the High Court has said in a judgment in favour of catalogue company Littlewoods. 

The company had argued that it should be entitled to compound interest on the overpaid tax, which had been charged in breach of EU law on commission. Paying compound interest rather than simple interest would increase Littlewoods' claim by £1.2 billion.

In the first trial on the claim in 2010, Mr Justice Vos referred the matter to the Court of Justice of the European Union (CJEU). In July 2012 the CJEU gave its judgment, referring the case back to the High Court, ruling that a person who has overpaid VAT which was collected contrary to EU law is entitled to reimbursement of the tax and to the payment of interest but saying that "it is for national law to determine, in compliance with the principles of effectiveness and equivalence, whether the principal sum must bear 'simple interest', 'compound interest' or another type of interest."

The CJEU said that national rules on the calculation of interest due "should not lead to depriving the taxpayer of an adequate indemnity for the loss occasioned through the undue payment of VAT". However, it was for the UK courts to determine "whether that is so in the case at issue ... having regard to all the circumstances of the case".

Simple interest is calculated only on the original or 'principal' amount, or on that portion of the principal amount that remains unpaid. Compound interest arises when interest is added to the principal amount, meaning that, from that moment, the interest that has been added also earns interest.

Littlewoods had mistakenly overpaid VAT on sales dating back to when VAT was introduced in 1973 as it had not deducted the commission it paid to the agents who had collected sales from its customers from the value of those sales. HMRC has already repaid the VAT together with simple interest.

Deciding that Littlewoods was entitled to compound interest, Henderson J said "Now the ECJ has confirmed that there is a right to interest under EU law in respect of all repayments of taxes levied contrary to EU law, the same consequence must in my judgment follow.  Only compound interest will suffice to satisfy the claimants’ EU law right to interest."

He said that the meaning of the “adequate indemnity” test in the CJEU's judgment is that "it requires payment of an amount of interest which is broadly commensurate with the loss suffered by the taxpayer of the use value of the tax which he has overpaid, running from the date of payment until the date of repayment."

The judge said that the market value of the use of money is normally measured by compound interest, and "justice will normally be done only by treating the defendant as if he had received a loan of the money on ordinary commercial terms for a borrower in his objective position". 

Littlewoods claimed interest not on the loss of 'use value' of the overpaid VAT in their own hands, but on the 'use value' of the money in the hands of the government, using this as a minimum measure of their own loss. They relied on the evidence of economist Professor John Kay, that the use value of the money to them would be significantly higher than to the government.

HMRC's expert argued that it was wrong in principle to use the time value of money as the measure of the government’s enrichment, and that the focus should instead be exclusively on the benefit which the government actually obtained from the use of the money. 

The judge said that the benefit to the government from the overpayments of VAT was correctly measured by the objective use value of the money, which would translate into an award of compound interest computed as Littlewoods had contended.  He said "the actual use made by the Government of the overpayments, and the actual benefit which the Government derived from them, are in my opinion irrelevant to the objective measure thus ascertained."

The judge said that "even if actual benefit were the correct measure of restitution under English law, it would be precluded by EU law if the actual benefit fell short of the objective use value of the money".

HMRC had also argued that the payment to Littlewoods should be reduced by the additional corporation tax which Littlewoods would have had to pay if the overpayments of VAT had never been made. The judge said that no account should be taken of the additional corporation tax.

In the first trial and the reference to the CJEU, HMRC had admitted that Littlewoods had overpaid the relevant VAT. However, in March 2013, HMRC applied to amend their defences so as to withdraw their admissions of liability and their admissions that the payments of VAT had been made under a mistake of law, because of the CJEU decision in the Grattan case. The CJEU ruled in that case that catalogue companies cannot retrospectively deduct the value of commission payments made to their agents from their total sales for the purposes of calculating their VAT liability. However, Henderson J said that it was not open to HMRC to reopen the underlying tax issues, "because it would be an abuse of process to permit them to do so".

Jason Collins, a tax expert at Pinsent Masons, the law firm behind Out-law.com said that in view of the sums involved, HMRC would want to appeal the decision. He said "this long-running fight has still some way to go. The High Court's judgment has helped to clarify a number of issues - but the question of whether the remedy should be given there or via the tax tribunal still needs to be resolved".

In a separate decision, last month, the Court of Appeal ruled that the repayments of VAT received by one of the Littlewoods group companies, Shop Direct Group, were subject to corporation tax.